WEEKLY COMMENT 15-01-2015
By Barry Edwards
The Swiss National Bank Policy Change
The news this week has been dominated by the Charlie Hebdo event and kept the change of policy by the Swiss National Bank (SNB) out of the main headlines. The same applies to the preliminary decision by the European Court of Justice (ECJ) that the European Central Bank (ECB) would not contravene the rules if it decides to start quantitative easing and buy European government bonds. The two announcements are interlinked and will have major implications for the economies of many European countries.
In case you have not heard about these two announcements, the SNB was supporting the Swiss franc at a fixed rate of SF 1.20 to the euro and had accumulated enormous foreign currency reserves while it has been in force. They decided on Thursday morning not to maintain this support and the Swiss franc immediately increased in value and the rate moved to .86 to the euro but did recover and settled at 1.05 overnight. That is a 39-15% range in value which is unheard of in recent times for a major currency; it is currently at the time of writing 1.04 but it is likely to be subject to large movements for a while yet.
The SNB announced earlier in the week that they were happy with the 1.20 rate cap but the ECJ announcement changed that policy instantly since it is likely that the Euro will depreciate against all major currencies if the ECB begins to buy EU government bonds. It is expected that the ECB will announce they will start quantitative easing at their meeting next week. That would mean that the SNB would be buying massive amounts of Euros which would mean they could incur substantial losses since the currency would be overvalued in today’s markets and they would have to remove the 1.20 rate cap anyway. The foreign currency traders are not happy with the SNB for confusing the market and many have incurred substantial losses as a result.
I suspect many people are not concerned about the FX traders but it is the economic implications that will cause big upsets for many people in the EU. The main reason is very low interest rates in Switzerland; many people in the EU have taken out mortgages in Swiss francs, especially in Eastern European countries. This sudden movement in the exchange rate means the cost of the repayments will rise and this will have a serious impact on the growth potential in the EU. In my view, the rate is likely to settle around 1.0 Swiss franc to 1.0 Euro and maybe slowly increase from there. Clearly, that is bad news for anyone with Swiss franc mortgages. The other negative impact of this decision is the deflationary effect on the Swiss economy and the large increase in the cost of Swiss exports which are substantial for a small country.
The reality is that adopting QE was difficult without the ECJ ruling and politically it was considered impossible without the Germans being on side. All in all this will mean the benefits of starting a QE programme now will not be as effective as it could have been if it was done a couple of years ago. The ECB is being forced to begin a QE programme since the EU economy is now in a deflationary period which is conflicting with their commitment to maintain a policy of 2% inflation.
These two announcements are creating more problems for the EU which was not anticipated a week ago. Although the EU economy is not as bad as many make out, anything that disrupts and causes doubt in the minds of business leaders does effect the recovery in the EU. Ultimately, the QE programme should have an effect on the Euro exchange rate which will encourage exports. It is the eastern and southern EU countries that will get the greatest benefit since most of their products are price sensitive in the global markets. However, QE does take time to work through the economy and the exchange rate gradually falls as the programme is implemented. Interest rates in those countries will start to decline providing a further boost to investment which has been lacking for some time.
Most commentators are finding it difficult to predict what will happen to the EU economy over the next year. It is not easy to see where the longed for growth is going to come from since many expect China and the emerging countries to struggle to achieve much growth this year and the USA may well be effected by the lack of expansion in world trade. The fall in commodity prices is being taken as a warning that demand from industry is slowing and the world economy is not likely to grow this year above trend. 2015 is not looking like the year that will finally sweep away the effects of the great recession especially since the magic of central bank manoeuvring looks like it has started to wane.
The fall in the price of oil is the real bonus for most economies around the world which will help to put more spending power in the hands of people who have struggled to make ends meet over the last few years. Providing the price remains around this level which most commentators expect, we should see some demand return helping to counter the pressures on the world economy.
That’s all for this week, more observations next week.